The Myth of the Marginal Income Tax Rate

Nobody ever said economists were perfect. Economics necessarily smoothes away the complicated marginalia of actual economic life, in order to produce models that will work simply and fairly accurately. Generally this does not pose too much of a problem. But when a simplifying assumption of economic models becomes a piece of common wisdom; when it is allowed to dictate policy as though it were true rather than merely convenient to suppose, then it becomes necessary to purge this assumption from our discourse. I’ll be taking on one such assumption right now: the claim that higher marginal income tax rates discourage work. Though an article of faith in economic policy, this misguided belief actually stems from inaccurate assumptions made to simplify economic arguments. When compared to the real world, it simply does not hold water.

Before writing about marginal income tax rates, I should clarify what those are, and address a common misconception. The idea behind marginal income taxes is that people who are wealthier ought to pay a large fraction of their wealth in taxes than people who have less. The way that this is accomplished is through a series of tax brackets with different rates.

However, the rates are not applied to one’s entire income, only the money earned in each particular bracket. Imagine that there were only two brackets: ten percent up to $100,000 and 20 percent above that. Someone making $100,001 isn’t taxed 20 percent on their entire income (or $20,000.20), they’re taxed ten percent on the first $100,000 and 20 percent only on that extra dollar (for $10,000.20) total. If the rates were applied one’s entire income, it would be possible to earn more and take home less after taxes, since they are only applied to the marginal dollar—that is, the money earned above the limit, this is never possible. Under an ordinary progressive income tax, it is never possible to earn more and take home less. You just take home a slightly smaller slice of that extra dollar.

Nevertheless, some argue that higher marginal income tax rates discourage productivity. The argument goes something like this. People choose how much they work, weighing time spent working against leisure time. High marginal rates mean that working more is slightly less valuable than it would otherwise be, making leisure time comparably more attractive, encouraging people to rest rather than work, and discouraging economic activity.

This argument may seem compelling, but it is fundamentally in error. First, it misrepresents how working people make decisions about spending. The idea of working more hours in order to buy a greater quality of leisure time may make sense to the child who picks up a paper route in order to buy new videogames. But adults, even very wealthy adults, do not think this way. Instead, adults work to maintain a standard of living. That standard of living may be high, but once one reaches it, it’s hard to give up.

First-year associates and senior partners at a law firm both manage to spend their entire paycheck each month on “necessities,” despite the differences in income—because the senior partners have assumed ongoing costs (larger mortgages, expensive vehicles, domestic service, etc.) that they are loathe to give up. In short, adults at nearly every level of income work not to goof off but to make the bills. Since the bills are still there, regardless of the marginal income tax rates, adults do not decide to work less because it’s slightly less valuable. They rely on taking home the same amount a month and can’t simply give that up.

Second and even more importantly, by and large people do not and cannot choose exactly how much they’ll work for tax reasons. High-paying jobs are not available by the hour for specified pay; instead, they have assigned work and uncertain return. A doctor works when patients are sick; one can’t shirk a night of call for tax purposes. Lawyers can’t tell which client will push them into the next tax bracket, and they couldn’t afford to pass up that client if they could. Investment bankers can work up to one hundred hours a week; the job demands that amount of time. None of these highly paid professionals are slacking off because of the marginal income tax rate. They couldn’t if they wanted to.

Tax policy is a fantastically complex subject, and it’s not always easy to see which competing theory is in the right. But like all government policy, it must ultimately apply at the level of ordinary, individual citizens. If we base our policy on arguments that contradict everything we know about how professionals actually work and live, we’re making a terrible mistake.

Louis R. Evans ’13, a Crimson editorial writer, is a social studies concentrator in Currier House